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DATE: FEB 3 2010 


Don’t expect lasting stability

Our basic view remains unchanged; always a big part of the game; in today’s

we remain positive on equity markets, credit context, we can’t attach much confidence to

spreads and most commodities because any of them. Rather, it makes more sense to

liquidity flows are still very positive and key think in terms of whether the environment is

indicators discussed below are supportive. favorable for assets or not and to watch for

However, we still are very concerned about benchmarks to gauge when that might

the artificial nature of the economic change and how it would affect the different

recovery and financial markets and when the markets.

relatively benign environment might change One thing we do know: markets

for the worse. eventually correct disequilibria and it is

Past issues have pointed to the usually painful. However, time lags are

widespread and huge disequilibria in the variable and frequently longer than most

U.S. economy and financial system. That is people can imagine. But when the

also true globally. No one knows what’s real adjustment comes it is usually swift and

and what is not when it comes to the substantial. This makes for an uncertain

economic recovery and market prices for environment because the risks are not easily

assets and currencies. Market forecasts are quantifiable.

Boeckh Investments Inc., 1750‐1002 Sherbrooke St. W., Montreal, Qc. H3A 3L6 Tel. 514‐904‐0551, 

problem in the short run when the U.S. potential bubbles in asset markets. and many more. These must net new U. the future of the U.6 trillion or 10. budget government debt ratios which will be deficit.S.S. the the government debt to GDP ratio is not a two-tiered unstable global monetary system. government debt? In an ratios of this deficit and many more into the interesting recent piece. the explosion in the deficit and recovery.S. Treasury Debt components to the issue of disequilibria that As we have pointed out frequently in relate to the sustainability of the economic past letters. we look at one of the rates as people are looking ahead to key problem areas . government rigged housing market. the economy is in recession. possibly quite fast. near private savings are rising.S. But now that the economy is dollars of underwater and illiquid structured growing. It is projected by the President to be anything but moderate. the hundreds of billions of moderate.” Eric Sprott and David next few issues of our letter. financing the financial products.S. The Who has been buying the massive resulting impact on U. government debt last year to be addressed if the investment environment finance the budget deficit and other cash is to have some hope of lasting stability. government debt issues of U. dollar. the dollar is firm zero interest rates. In the Ponzi Scheme?. requirements.funding the U. deficit may not be easy at existing interest In this issue. the $10 trillion private and the existing debt ratios relatively debt overhang. “Is it all Just a future will have serious consequences. we will look at Franklin looked behind the published some of the other imbalances and numbers to see who bought the $2 trillion of disequilibria mentioned above.S. inflation is low.   There are a number of important Financing the U.6% of GDP this year. $1. The Treasury data shows the The  Boeckh Investment Letter    2  .

e. These two likely that ex ante demand will shrink categories . investments. are flow of funds data shows that the getting noticeably nervous about the dollar ‘Household” sector was the largest net and their U. The U. they are used to “balance” the If that is the case. If supply is greater than demand. Similarly. The savings rate may now be starting   to fall again as consumers start spending The  Boeckh Investment Letter    3  . What is interesting is the ex ante (before the fact) supply and demand balance. interest rates rising). holdings of government debt by 200% in Foreign and international buyers. Prices. It is. therefore. by far the biggest purchasers last year. the price must fall to clear the market. who were 2008 and 2009 (Charts 1& 2).   “Other Investors” sector increased its more as the government sincerely hopes.“Other” from Treasury relative to supply. savings rate rose sharply during and after the crash which created liquidity to buy the greatly increased government bills and bonds. supply always equals demand. purchaser in late 2008 and 2009.S. what are the numbers. Treasury’s options? In financial markets as in other markets.  add up.S. may statements and “Households” from FRB have to start falling a little more briskly to statements are residuals: if the figures don’t clear the markets (i. That Chart 1& 2  is a tautology and an ex post (after the fact) identity. therefore.

trouble funding its cash requirements. The risk is that the crisis. Funding the deficit would to shorten the maturities of the bonds they The  Boeckh Investment Letter    4  . Because interest rates are agencies tend to react late and pile on to below equilibrium levels. Democrats in a precarious political situation That is the second option open to the and the Republicans smelling blood. rates and 3. with the increases would be evenly balanced.S. expectations much more attractive unless investors think could become totally unhinged. increases in the future and. rising and Treasury auctions will start to go downgrade would be a disaster. In an election year. A world it is a one off price level adjustment. The which has been getting addicted to near zero reality is that if Treasury yields start to rise. In the interest rates will not make Treasury bonds event of a U. short-term U. hence.   The first option is a pre-emptive one.5% on 10 year investors will actually become more bearish Treasuries may not react very well if there is as they would begin to anticipate further a sudden and large change in rates. sustained The third option for the Treasury is capital losses. fall in price could be huge and trigger a If the Treasury begins to have credit downgrade by rating agencies. then become more difficult. by Sovereign credit downgrades is a very hot definition that means interest rates will be topic in the media these days and a U. forget Treasury in this event – letting prices fall it.S. downgrade. Rating badly or fail. Congress won’t act until after a debt until the market clears. a moderate rise in protect their eroding reputations. setting in The Treasury via the Administration could motion a vicious circle that would tend to appeal to Congress to cut the borrowing push prices down rapidly to the point at requirement by slashing expenditures and which expectations of further declines or raising taxes.S.

vicious circle and The  Boeckh Investment Letter    5  . Chart 4  outstanding bonds have to be rolled over increasingly often and in huge amounts which compounds the problem of funding ongoing large cash requirements. Typically. These purchases were needed to the general public is 49 months. This has been term ones can’t be sold would be widely going on for over a year in the U..8% compared to The fourth option is the end point.6% at 10 years and 4. the Fed noted as the overall term to maturity would purchased $435 billion in the past 12 months shrink. It would shrink even collapsed (Chart 5). the two year yield is about . vulnerable to any bad news. We call this financial more rapidly than in recent years if the Chart 3  Treasury sells large amounts at the short end of the yield curve. government debt held by (Chart 4). the Treasury runs out of willing buyers and Selling short-term bonds because the longer.had term in 2001 (Chart 3). must sell to the central bank.   sell to points on the yield curve where makes government finances extremely interest rates are much lower. a falling average term to maturity in circumstances like today is interpreted as moving towards debt monetization. For example. As the term shrinks. At present.S.6% at 30 years. 3. a moderate support the Fed’s program of quantitative but certainly not a conservative figure and easing because the money multiplier – the much lower than the 70 months average ratio of bank reserves to money supply . This creates a dangerous.

confirmed by liquidation in bank lending. the Fed had to supply those reserves by buying assets in order to sustain liquidity flows. is still available. Charts 5-8 show that all four of these indicators illustrate that the environment Chart 8  remains benign and hence favorable for prices of risk type assets. The fourth is weak price inflation. as we saw in 2009. The first is weakness in the money multiplier. indicating that foreign support    Chart 7  for the dollar. These continue to be our main benchmarks and must be   The  Boeckh Investment Letter    6  .   dramatically while private credit demand Chart 5  collapsed.   constipation because commercial banks watched closely for any sign of significant increased their demand for reserves negative change. The second is a relatively stable dollar. while not great. The third is relatively stable long- term bond yields. The Fed can monetize Treasury bonds in the short run with little    Chart 6  consequence under particular conditions.

occurred. They are still obsessed with the project strong growth is based on past millions of factory jobs lost as a result of experience which shows deep recessions are collapsed exports.S. The authorities are predicting a mini boom to last for some unlikely to risk a significant economic time. We don’t buy this argument January was a month of correction. It is far from clear that clampdown on bank lending and increased strong growth can be extended much beyond reserve requirements to counter too rapid the first half of 2010 when inventory economic growth and strong asset price adjustments will have been made. and international stock markets were Much of what lies behind the U. by as much as 10%.S. the expectations of continued easy To summarize. their objective is to take followed by rapid recoveries. the money and ultra low interest rates would somewhat stable status quo in financial markets will remain in place for the time The  Boeckh Investment Letter    7  . Shanghai was cyclical experience to project growth in the hit hard because the government ordered a next few years. not kill it. interest rates Commodities and precious metals also sold will probably be higher and the housing off in January. the increases in some real estate markets.   Investment Conclusions soon evaporate. virtually all down. 4th quarter GDP data indicate China. is likely to remain almost 6 % real growth and many are an important positive. however. If this the steam out of excessive growth. stimulus money will be spent. in our view. U. U.S. some by negligible economic recovery is artificial and amounts. others such as the key Shanghai temporary and it is dangerous to use past market. One of the main arguments used to slowdown. of sustained rapid economic growth. rebound may well have faded.

probably at least until mid-year. These oversold levels. corporate the U. value. hovering on either side of Keep overall exposure to risk below normal. To re-iterate.not bad for financial and leverage in that sector is falling. The The  Boeckh Investment Letter    8  . The recent correction is indicators continue to be stable and as long healthy and gains will be much more muted as this is the case. We cannot emphasize should slow by mid-year but remain too strongly that the investment and positive. On a rate of change basis.S. rebound from very corporate bonds and Treasuries. the overall environment than in 2009. benchmarks are: the trade weighted value of The sharp rise in stock. and the spreads between risky mainly a catch-up. environment will remain conducive to good subject to the risks outlined above which investment profits for those who do their relate to the massive disequilibria homework in searching out compelling everywhere. remain very low. However. the overall will remain favorable for risk assets. zero depending on the particular measure. highly liquid and awash in nearly free corporate liquidity is good on balance and money . Price inflation will in-Wonderland economics don’t last forever. the 10 and 30 year Treasury bond and commodity markets last year was yield. Alice- requirement if need be. The Fed will continue to monetize economic world is totally artificial and at a large part of the Treasury borrowing some point an adjustment will come.   being. The overall environment will remain Profits will continue to recover well. these toward zero after mid-year. the jump in Watch the key benchmarks for significant energy and food prices will head back negative change. Economic growth time for complacency. But it is no commodity markets. Wealth preservation should be paramount. dollar.

That will mark a time to become more concerned about valuations.   money multiplier should also be watched for signs that the Fed’s effort to expand its balance sheet and bank reserves is finally gaining traction. super BoeckhInvestmentLetter. In the starts to strengthen significantly. The  Boeckh Investment Letter    9  .Com February 3. 2010 expansionary liquidity conditions will begin to reverse. When it Tony & Rob Boeckh info@bccl. They always do in the first leg up in a cyclical bull market. As Chart #5 shows. the money multiplier is still very weak. investors should continue to ignore the widespread view that “the markets have outpaced fundamentals”.

  Stocks           The  Boeckh Investment Letter    10  .

  Commodities         The  Boeckh Investment Letter    11  .

    Currencies The  Boeckh Investment Letter    12  .

  Interest Rates The  Boeckh Investment Letter    13  .

  Corporate Spreads and Vix                                 The  Boeckh Investment Letter    14  .